Insurance agents are often asked: “What limits of liability should I carry”. The standard answer is: “As high as you can afford and makes sense”. This of course is simplistic and not very satisfying.
Limits for most commercial liability insurance policies, such as General Liability, Autos, Professional and Directors & Officers usually start at $1,000,000 and can go up in increments to as high as $2Mil, $5Mil or perhaps 50 million dollars. Sometimes minimum limits are imposed by statute or contract to meet financial responsibility requirements. But most of the time, it’s the buyers’ choice.
How can we help the insured with this decision? I usually go through a process using the following criteria:
1. The “Assets” Model. Carry a limit sufficient to cover your assets that could be converted in a worst case scenario claim against you. This limit can be in some realistic proportion to the net worth of the client. For instance, if my buildings, fleet and investments are worth $3,000,000., I might survive a claim that is a little higher than my $1,000,000. policy limit, but I would be devastated by a $4,000,000 claim.
2. The “Peer” Model. What do other organizations my size in my industry carry? The agent’s own customer base or a survey could reveal what is “average” or “common” for a customer’s comparative profile. Using such conventional norms is certainly a safe method, though it often fails to pick up on a given insured’s nuances or unique “risk personality”. My competitor down the street or my peer organization may be prudently carrying limits as high as mine, though they may also be taking more risk with a lower limit to save cost, get an edge or impress the budget watchers. Or despite our similarities, I might feel that we have more risk, so I carry a higher limit.
3. The “Anecdotal” Model. There’s nothing like actual stories or claims examples to illustrate the action of limits and exposures. What can happen? What has happened out there? How high a verdict have we seen in cases like we could have? High profile news stories or lesser known cases are reference points in imagining what could happen with our own businesses. A client with D&O limits of $2,000,000 had a catastrophic claim with a settlement of $4,000,000. Other assets had to be converted to make up the difference. Could that happen to me? Not likely, but it happened to my friend.
4. The “Market” Theory. This cynical approach games the judicial system that allows a plaintiff to find out what insurance limits their opponent carries. Rather than demanding actual damages, the lawsuit is for however much they think they can get, as in the top limit of the insurance policy, which becomes the amount of “damages” demanded in the complaint. Some insureds don’t want to carry high limits of liability for fear that such a high limit will become a “target” that encourages a big lawsuit. If the limit is lower, so goes this theory, maybe the demand will be lower too. I never recommend this approach, since high damages could be legitimate and skillful plaintiffs attorneys can find assets to get at beyond insurance limits.
5. “Affordability”. The cost of incrementally higher limits is much smaller than the cost of the base limit or for each increment above that. Buying as much as you can afford can help eliminate some of the guesswork. As with other business decisions, you will be using cost / benefit analysis in figuring the limit you want to buy. If you perceive that your risk is relatively low, you may not spring for the costlier higher limits. If you’re feeling extra prudent, there’s room in the budget, or the cost just came down, you may go with the higher limits, using some of the other criteria as your guide.
6. The “Sleep” Factor. This is my favorite principle, because it concentrates all of the other factors in coming up with a limit that the insured can be comfortable with. Given all the information, I will ask a client: “What dollar limit would you have to carry that allows you to keep from losing sleep or worrying too much”? The client needs to “feel” reassured that the limit picked is reasonable, prudent, well-informed and adequate. If buying a little higher limit will contribute to better sleep, then go for it.
There are really no scientific “rules of thumb” for choosing a limit of liability. Get help from an experienced insurance professional to obtain all the information you can about your exposures, available limits, competitive quotes and your industry best practices. Then test your own tolerance for risk and check your budget. When you’ve done this homework, then make your decision and sleep on it.
Jim Stickney, President - Insurance Service of Asheville, Inc.